As things slowly swing back into action for the new year, so too do the flow of market forecasts and predictions. The last few newsletters I received in my inbox really got me thinking…
Let’s begin with clarifying what I mean by a ‘forecaster’. Forecasters claim their able to predict the future movements of the share-market, quickly entering the share-market before it goes up and getting out before it goes down. And the process continues so on. Easy, right?
Have you ever wondered how often a ‘market-timer’ needs to be right in order to beat a basic index? Lucky for you, someone has already undertaken this study. This someone is Nobel Laureate William Sharpe (if you want to know a little more about William F. Sharpe, click here). He set out to answer that very question in his 1975 study titled, “Likely Gains from Market Timing”.
Sharpe wanted to identify the percentage of times a market timer would need to be accurate to break even relative to a benchmark/index portfolio. The conclusion (without boring you will all the technical and ‘in-between’ stuff), a market-timer must be accurate 74% of the time in order to outperform a passive portfolio at a comparable level of risk, according to Sharpe.
In 1992, SEI Corporation (a financial services company based out of Pennsylvania, USA) updated Sharpe’s study to include the average 9.4% stock market return (pa) from 1901-1990. Their study determined that the gurus must be right at least 69%, and as high as 91% of the time, depending on the timing of the moves.
So then, how often do market timing gurus get it right in reality? Again, someone has already done this work for you. CXO Advisory Group (a stock market research company) tracks public forecasts of self-proclaimed market-timing gurus and rates their accuracy by assigning grades to them as “correct,” “incorrect” or “indecisive”. The chart below (thanks to Index Fund Advisors) illustrates CXO’s analysis for 28 well-known market-timing gurus who made a collective 4,629 forecasts from 2000 – 2012. As you can see from the table below, not one of these gurus was able to meet Sharpe’s requirement of 74% accuracy, or SEI’s minimum of 69%. All failing to beat a basic index portfolio.
Let’s not forget that the share-market is a zero-sum game. For every transaction there is a winner, and there is a loser. For an investor to believe they will be on the winning side of these transactions each and every time is fantasy. The proof is in the pudding.
“Sure, it’d be great to get out of stocks at the high and jump back in at the low, but in 55 years in the business, I not only have never met anybody who knew how to do it, I’ve
never met anybody who had met anybody who knew how to do it.” – John Bogle
Missing the Best & Worst Days
Almost all big gains and drops in stock-markets are concentrated in just a few trading days each year. Simply missing a few of these days can have a dramatic impact on an investor’s return. The chart below (thanks to JPMorgan) illustrates how an investor who remained invested in the S&P 500 Index throughout the 20-year period from 1995 to 2014 (that’s over 5,000 trading days) would have earned a handsome 9.85% annualized return, growing a $10,000 investment to $65,453.
When the investor missed the five best-performing days in that time period, the annualized return dropped to 6.10%, with $10,000 growing to $32,665, and if the investor missed the 20 days with the largest gains, the return dropped yet again to just 3.62%. If the investor missed the 40 best-performing days, their investment in the S&P 500 in fact turned negative, with $10,000 eroding in to just $9,140.
Trying to time the market is extremely difficult to do consistently. Market lows often result in emotional decision making. Investing for the long-term while managing volatility can result in a much better financial and mental outcome.
When it comes to investing, investors need to look beyond the short-term and make investment decisions not based on intuition or forecasts, but based on hard evidence and facts.
Please note that all information provided within this article is of a general nature and does not take into account your current financial situation, needs or objectives. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. Baharian Wealth Management recommends investors obtain financial advice specific to their situation and consider the Product Disclosure Statement prior to making any financial investment or insurance decision.